Is India Ready to Relinquish Control of its State-Owned Banks?

A Reserve Bank of India panel is seeking feedback on whether the government should give up control of the state-owned banks.

Punit Paranjpe/Agence France-Presse/Getty Images

A Reserve Bank of India panel this week asked bankers, bureaucrats and policymakers to consider whether New Delhi should give up control of the state-owned banks that dominate India’s lending landscape.

The ambiguous answer, analysts say, is: Yes it should, but no it won’t.

Maintaining a massive network of often money-losing, state-controlled banks is expensive, but it will be tough for the government to give up control as it still wants to have a voice in how the banks lend and spend.

Advertisement

“The government will need a strong political will and getting it done quickly will be a challenge,” said Dhananjay Sinha, head of research at Emkay Global Financial Services Ltd.

The central bank panel suggested that New Delhi should either privatize national banks by lowering its stake in them to less then 50% or put in place a new structure to stop the meddling in how the banks are run. It suggested the government move all its holdings in banks to a new investment company. It also suggested that bank boards should be allowed to function without government interference.

The panel–formed to review the governance of bank boards and headed by former Axis Bank Ltd. chief executive officer P.J. Nayak–is accepting feedback on the recommendations until June 12.

India has 27 public sector banks in which the government has at least a 51% stake and they are often not good investments. With recent slow economic growth, state-run banks have seen a sharp rise in bad loans. To keep them afloat and expanding, the government in recent years has had given them regular capital infusions.

“Reduction in government shareholding has become imperative given the recapitalization requirements and also the loan-loss risks,” Mr. Sinha said.

Still, New Delhi has been reluctant to relinquish control. The state-run banks account for no less than three-fourths of the lending in the country. Politicians and bureaucrats sometimes try to use them to promote their causes, a benefit they do not want to give up.

State-run banks have two masters – the Finance Ministry as well as the Reserve Bank of India. In addition to the regulatory orders from the RBI, they regularly receive missives from the ministry to push the social agenda of the government. In the period from October 2012 to January 2014, for example, the Finance Ministry issued 82 circulars to public sector banks, the RBI panel report said.

“It is a fundamental irony that presently the government disadvantages the very banks it has invested in,” the report said.

These banks also fund much of the government’s annual borrowing program, which in recent years has been close to six trillion rupees ($100 billion). The government currently mandates that 23 rupees out of every 100 rupees with the bank should be invested in government bonds. For state-run banks, the average government bond holding is much higher. Should the banks allowed more independence, they may not choose to carry so much of the country’s debt.

Even if politicians and bureaucrats in Delhi could agree to loosen their grip, the decision to reduce government holding in these banks would invite the wrath of the industry’s labor unions which have the power to cripple the economy by closing down banks.

About India Real Time

India Real Time offers analysis and insights into the broad range of developments in business, markets, the economy, politics, culture, sports, and entertainment that take place every single day in the world’s largest democracy. Regular posts from Wall Street Journal and Dow Jones Newswires reporters around the country provide a unique take on the main stories in the news, shed light on what else mattered and why, and give global readers a snapshot of what Indians have been talking about all week. You can contact the editors at indiarealtime(at)wsj(dot)com.